The Reserve Bank will be acting this morning to reduce overnight interest rates,
by 0.5 per cent, to around 5.25 per cent. Reductions in bank and other interest
rates can be expected to follow.

This action, which follows discussions yesterday with the Government, is consistent
with the position outlined by the Reserve Bank in its January Bulletin:

‘The combination of low inflation and weak economic activity would ordinarily
provide a case for easing of monetary policy. Current nervousness in foreign
exchange markets, however, which follows earlier falls in the exchange rate,
effectively precludes any such action at this time.’

At its meeting on 2 March, the Bank's Board reaffirmed this position. It noted that
the foreign exchange market was showing signs of settling down but that the
election period contained the potential for renewed instability. In the event,
however, financial markets have exhibited considerable robustness over recent
weeks, with the exchange rate strengthening and bond yields falling.

Economic activity is stronger now than six months ago but it is not moving ahead
fast enough to make inroads into the level of unemployment or excess capacity
more generally. The provision of credit, particularly to businesses, remains
flat and business investment has shown only tentative signs of recovery.
At the same time, further evidence has emerged of lower inflation, lower
inflationary expectations and negligible wage pressures. In these circumstances,
a further reduction in interest rates is appropriate; it will help to support
the recovery without adding to inflationary pressures.

Looking ahead, Australia is well placed to move into a period of sustained, low inflationary
growth. This, however, will require a further pick-up in private investment
if capacity constraints are to be avoided down the track. To that end, the
Budget deficit will need to be reduced over the medium term to provide room
for a rising level of business investment.

Lower interest rates will assist business cash flows and make some contribution to
encouraging investment. In contrast to lending for housing, which is continuing
at high levels, lending to business remains weak. Today's reduction in cash
rates will reduce funding costs of financial institutions which the Bank
expects to flow through to banks' lending rates. In this process, the Bank
would like to see priority given to reductions in lending rates for business
borrowers.

The lower cash rates will also flow through to deposit and investment rates, which
will reduce nominal interest returns to savers. Given low current and prospective
rates of inflation, however, any erosion of the real value of these savings
will be much less than it was in earlier periods of high inflation.